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Protecting Your Company’s IP Through Non-Compete and Other Restrictive Covenants

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Protecting Your Company’s IP Through Non-Compete and Other Restrictive Covenants

Prepared and Presented by: Jeffrey B. Oberman

I. INTRODUCTION.

More employers (“OLDCO”) than ever are using non-competition, confidentiality and non-solicitation agreements to prevent unfair competition and solicitations by their employees, and to protect their trade secrets and confidential information.  This article summarizes the legal issues relating to such agreements, and provides strategies and practical suggestions to help employers accomplish their business protection goals, and minimize their risks of expensive litigation.

II. OLDCO’S POTENTIAL CLAIMS.

OLDCO can assert several claims directly against their former employees, which can also directly or indirectly impact their new employers (“NEWCO”).

A. Breach of Contract; Tortious Interference with Contract. In addition to a direct claim against the former employee for breach of contract, tortious interference claims can be asserted against the former employee and NEWCO.  OLDCO may assert an interference claim where the employee and NEWCO interfered with a contractual relationship with OLDCO’s customers.  See, e.g., National Recruiters, Inc. v. Cashman, 323 N.W.2d 736, 741 (Minn. 1982); United Wild Rice, Inc. v. Nelson, 313 N.W.2d 628, 632 (Minn. 1982); Bennett v. Storz Broadcasting Co., 134 N.W.2d 892, 897 (Minn. 1965).  If NEWCO hires an employee who is subject to a non-compete agreement, NEWCO may be liable to OLDCO for tortious interference with contract.  Kallok v. Medtronic, Inc., 573 N.W.2d 356 (Minn. 1998).  NEWCO may also be required to indemnify OLDCO for attorneys’ fees incurred by OLDCO in litigation to enforce the valid non-compete agreement.  Id. The employee may have several contracts with which he or she could be accused of breaching and with which NEWCO could be accused of interfering.

1.                      Non-Compete Agreement. In Minnesota[1] a non-compete agreement can be enforced to the extent it is necessary to safeguard OLDCO’s protectable interests and reasonable as between the parties.  See Bennett v. Storz Broad. Co., 134 N.W.2d 892 (Minn. 1965); Lemon v. Gressman, 2001 WL 290512 at *1 (Minn. App. Mar. 27, 2001); Medtronic, Inc. v. Sun, 1997 WL 729168, at *3 (Minn.  App., Nov. 25, 1997).

2.                      Agreement not to Solicit Customers. Restrictions on solicitation of customers have been deemed enforceable as protecting the good will of OLDCO’s business.  See Dynamic Air, Inc. v. Bloch, 502 N.W.2d 796, 800 (Minn. App. 1993).

3.                      Agreement not to Solicit Employees. In Frank B. Hall & Co., Inc. v. Alexander & Alexander, Inc., 974 F.2d 1020 (8th Cir. 1992), the court was not asked to rule on the validity of the employee non-solicitation agreement, but its decision assumed its enforceability.

4.                      Confidentiality Agreements. Even employees without non-compete agreements may have confidentiality agreements that protect OLDCO’s confidential information and trade secrets.  See, e.g., Electro-Craft Corp. v. Controlled Motion, Inc., 332 N.W.2d 890 (Minn. 1983).

B. Violation of Trade Secret/Confidentiality Laws. Regardless of the existence of agreements, the former employee and/or NEWCO may also have direct or indirect liability to OLDCO for violations of trade secret and/or confidentiality laws.  The employee has a duty to protect the secrecy of OLDCO’s confidential information, and NEWCO cannot benefit from a violation of that duty.

1.                  Employees’ Common Law Duties to Maintain Confidentiality. Regardless of the existence of a contractual agreement, Minnesota common law provides protection to employers from employees that misuse an employer’s confidential information, or attempt to compete with the employer while still employed.  See Eaton v. Giere, 971 F.2d 136, 141 (8th Cir. 1992) cert. denied, 506 U.S. 1034 (1992) (finding employee violated fiduciary duties of confidentiality and loyalty when he courted employer’s customers with product that combined both employee’s invention and employer’s confidential information).  But the employer-employee relationship creates a common law duty of confidentiality only as to information that the employer treats as secret.[2] Electro-Craft Corp. v. Controlled Motion, 332 N.W.2d 890, 903 (Minn.1983)  (finding no misappropriation where employer never treated information as secret, despite existence of agreement prohibiting the taking of secrets).   Further, a common law claim of misappropriation of confidential information requires an affirmative showing that the employee intended to misappropriate the employer’s confidential information.  Conus Communications Co. Ltd. P’ship v. Hubbell, No. C5-99-2131, 2000 WL 979133, at * 3 (Minn. Ct. App. Jul. 18, 2000)  (refusing to find intent where employer did not provide notice that information was confidential, had no agreement with employee to that effect, and failed to implement adequate safety measures to protect confidential information).

2.                  Employee’s Statutory Obligation Not to Misuse Trade Secrets.  The Uniform Trade Secrets Act (“UTSA”) became effective in Minnesota on August 1, 1980, M.S.A. §§ 325C.01 to 325C.08; the UTSA displaces all conflicting tort law and serves to preempt the common law tort of misappropriation.  See Befort and Schanfield, 17 Minnesota Practice § 13.23.  Misappropriation is an action that allows for protection of certain types of information and is defined as “improper acquisition, disclosure, or use of a ‘trade secret.’” Electro-Craft Corp., 332 N.W.2d at 897 (quoting Minn. Stat. § 325 C.01, subd. 3).  The existence of a proven trade secret and proof of a confidential relationship are prerequisites to an action for misappropriation.  Id. Under the Minnesota Uniform Trade Secrets Act (MUTSA), the burden is on the party asserting misappropriation to establish each factor considered in determining whether information is a trade secret.  New Leaf Designs, LLC v. BestBins Corp., 168 F.Supp.2d 1039 (8th Cir. Ct.App. (2001).[3] (Manufacturer of plastic storage bins failed to show improper acquisition, disclosure, or use of design sketches and design innovations it considered trade secrets, as would show likelihood of success on merits of claim under MUTSA required to support manufactures motion for preliminary injunction to prevent competitor from using trade secrets, where manufacturer offered no proof that any of competitor’s employees viewed or possessed its design sketches.)  Id. at 1039.

3.                  Action for Trade Secret Protection: The OLDCO’s Prima Facie Case. To make out a claim for trade secret protection a plaintiff must prove the following elements:  plaintiff is the owner of a trade secret; plaintiff disclosed the trade secret to defendant; or defendant wrongfully took the trade secret from plaintiff without plaintiff’s authorization; defendant was in a relationship with plaintiff as a result of which defendant’s use or disclosure of trade secrets to plaintiff’s detriment is wrongful; and defendant has used or disclosed (or will disclose) the trade secret to plaintiff’s detriment; or, defendant who knew or should have known of plaintiff’s rights in the trade secret, used such secret to plaintiff’s detriment.  Surgidev, 648 F. Supp. at 680.  The fourth and final factor requires “proof that there is an intention on the part of the defendants to use or disclose the putative trade secrets, or alternatively, that under the circumstances of the case, there is a high degree of probability of inevitable disclosure.”  Id. at 695.  In Surgidev the court noted that other courts had under certain circumstances presumed that wrongful disclosure would take place.  The court, however, went on to note that it did not need to rely on a presumption of wrongful intent because the defendants had admitted their intent to use some of plaintiff’s customer information.  Id. at 695see also Electro-Craft Corp. v. Controlled Motion, Inc., 332 N.W.2d 890 (1983) (holding it is “well settled that detailed manufacturing drawings and tolerance data are prima facie trade secrets”); Henry Hope X- Ray Products, Inc. v. Marron Carrel, 674 F.2d 1336, 1340-41 (9th Cir.1982) (configuration of gear system and tolerances was secret).

4.                  Inevitable Disclosure Doctrine. The doctrine by which some courts presume, that, regardless of the intention to disclose, wrongful disclosure will take place is known as the “inevitable disclosure” doctrine.  See PepsiCo, Inc. v. Redmond, 54 F.3d 1262, 1269 (7th Cir.1995) (based on findings of inevitability of disclosure and defendant’s lack of good faith, enjoining the defendant from working for competitor for six months).  Id. at 1270-71; cf. Lumex, Inc. v. Highsmith, 919 F. Supp. 624, (E.D.N.Y.1996) (finding that, despite good intentions, defendant working for competitor would inevitably divulge former employer’s trade secrets); but see Hoskins Mfg. Co. v. PMC Corp., 47 F. Supp. 2d 852 (E.D. Mich. 1999) (granting summary judgment for defendant on inevitable disclosure claim where significant differences between companies’ manufacturing processes meant information from former employer would not be useful in new position); Schlage Lock Co. v. Whyte, 101 Cal.App.4th 1443, 125 Cal.Rptr.2d 277 (Cal. Ct. App. 2002) (covenants not to compete are generally prohibited in California and that the inevitable disclosure doctrine would create a “de facto covenant not to compete,” in violation of California’s public policy favoring employee mobility. Id.)  In Minnesota, generally a court may issue an injunction only where there is misappropriation or threatened misappropriation of trade secrets.  Seagate, 941 F. Supp. at 101; Minn. Stat. § 325C.02(a); see also NewLeaf Designs, 168 F. Supp. 2d at 1044-45 (holding that to obtain injunctive relief under UTSA, the moving party must show there is a high degree of probability of inevitable disclosure).[4]

C. Violation of Patent Rights. In the absence of an express contractual agreement defining ownership rights in inventions, the employer’s right to claim ownership in discoveries made by an employee depends on both the nature of the discovery and the nature of the employment relationship.  An employer can require an employee to assign ownership rights in past and future inventions, and should do so in writing.[5] The general rule is that “an individual owns the patent rights to the subject matter of which he is an inventor, even though he conceived it or reduced it to practice in the course of his employment.”  See, e.g., Banks v. Unisys Corp., 228 F.3d 1357, 1359 (Fed. Cir. 2000).  There are two widely recognized exceptions to the general rule:  “First, an employer owns an employee’s invention if the employee is a party to an express contract to that effect; second, when an employee is hired to invent something or solve a particular problem, the property of the invention related to this effort may belong to the employer.”  Banks, 228 F.3d at 1359.

D. Interference with Business Relations or Prospective Business Relations. Minnesota courts have recognized causes of action for wrongful interference with present and prospective contractual and business relationships.  See, e.g., United Wild Rice, 313 N.W.2d. 628 (Minn. 1982).  If the employee and/or NEWCO intentionally and improperly interfere with OLDCO’s current or prospective contractual relations, they may be liable for this tort.  Id. at 632-33.

E. Respondeat Superior. Under the doctrine of respondeat superior, an employer is “vicariously liable for the wrongful acts of its employees committed within the scope of their employment.”  Oelschlager v. Magnuson, 528 N.W.2d 895, 902 (Minn. App. 1995).  To establish that an employee’s acts occurred within his or her scope of employment, “it must be shown that the conduct was, to some degree, in furtherance of the interests of the employer.”  Hentges v. Thomford, 569 N.W.2d 424, 427 (Minn. App. 1997).  In an unpublished opinion, the Minnesota Court of Appeals held that a new employer may be held vicariously liable for an employee’s misappropriation of trade secrets.  See Hagen v. Burmeister & Assoc., 1999 WL 31130 at *3-4 (Minn. App. Jan. 26, 1999).  This theory could lead NEWCO to any number of other claims against it, which are typically asserted just against the employee. Regardless, claims asserted against the employee will affect NEWCO, even if NEWCO is not legally liable for the claims.

F. Breach of Duty of Loyalty. All employees owe a duty of loyalty to their employers. See, e.g., Eaton Corp., 971 F.2d 136 (8th Cir. 1992); Sanitary Farm Dairies, Inc. v. Wolf, 112 N.W.2d 42 (Minn. 1961).  Among other things, the duty of loyalty prohibits an employee “from soliciting the employer’s customers for herself, or from otherwise competing with her employer, while she is employed.”  Rehabilitation Specialists, Inc. v. Koering, 404 N.W.2d 301, 304 (Minn. App. 1987).

G. Breach of Fiduciary Duty. Partners in partnerships, and officers, directors and shareholders in close corporations owe even higher fiduciary duties to OLDCO.  See, e.g. Triple Five of Minnesota, Inc. v. Simon, 404 F.3d 1088, 1095 (8th Cir. 2005); Gunderson v. Alliance of Computer Professionals, 628 N.W.2d 173, 186 (Minn. App. 2001).

1.                  Corporate Opportunities. The fiduciary duty includes a duty not to take a corporate opportunity.  See, e.g., Diedrick v. Helm, 14 N.W.2d 913, 919 (1944). Under this doctrine, when a business opportunity related to OLDCO’s business is presented to an employee, he or she may not take it for personal benefit, or direct it to another person without first making the opportunity available to OLDCO.  See, e.g., Matter of Villa Maria, Inc., 312 N.W.2d 921, 922 (Minn. 1981).

2.                  Soliciting Employees. The fiduciary duty may also include a duty not to recruit other employees to leave OLDCO.  See, e.g., U. S. Anchor Mfg., Inc. v. Rule Industries, Inc., 717 F.Supp. 1565 (N.D. Ga. 1989); Duane Jones Co. v. Burke, 177 N.E.2d 237 (N.Y. 1954); Lowndes Prods., Inc. v. Brower, 191 S.E.2d 761 (S.C. 1972).  But see Headquarters Buick–Nissan, Inc. v. Michael Oldsmobile, 149 A.D.2d 302 (1989).

H. Remedies.

1.                  Injunctive Relief. OLDCO may seek injunctive relief. See, e.g., Ticor Title Ins. Co. v. Cohen, 173 F.3d 63, 68-69 (holding acknowledgement of irreparable harm in the agreement could arguably be viewed as an admission by the employee that his former employer would indeed suffer irreparable harm should he breach the non-compete provisions).

a.                   Standards for Injunction.  Under Minnesota law, the five Dahlberg Brothers factors are considered in determining whether injunctive relief should be granted: (1) the nature and background of the relationship between the parties preexisting the dispute giving rise to the request for relief; (2) the harm to be suffered by plaintiff if the temporary restraint is denied as compared to that inflicted on defendant if the injunction issues pending trial; (3) the likelihood that one party or the other will prevail on the merits when the fact situation is viewed in light of established precedents fixing the limits of equitable relief; (4) the aspects of the fact situation, if any, which permit or require consideration of public policy expressed in the federal and state statutes; and (5) the administrative burdens involved in judicial supervision and enforcement of the temporary decree.  See Webb Publishing Co. v. Fosshage, 426 N.W.2d 445, 448 (Minn. App. 1988) (citing Dahlberg Brothers, Inc. v. Ford Motor Co., N.W.2d 314, 321?22 (Minn. 1965)).  In a standard employment case involving the enforcement of a valid restrictive covenant, there are generally no statutory policies, administrative burdens, fiduciary or other significant relationships between the parties to consider; thus, the focus is on the balance of harms and the likelihood of success on the merits.  See Webb Publishing Co., 426 N.W.2d at 448.

The federal courts in Minnesota generally refer to the Dataphase factors identified by the Eighth Circuit in evaluating whether to issue injunctive relief: (1) the threat of irreparable harm to the movant; (2) the balance of the harms between the parties; (3) the probability that the movant will succeed on the merits; and (4) the public interest.  See Dataphase Sys., Inc. v. C.L. Sys., Inc., 640 F.2d 109, 113 (8th Cir. 1981).  The party seeking the injunction bears the “complete burden” of proving all of the Dataphase factors.  Gelco Corp. v. Coniston Parthers, 811 F.2d 414, 418 (8th Cir. 1987).

b.                  Irreparable Harm.  A court may infer irreparable harm where it can be shown that an employee breached an enforceable restrictive covenant. Overholt Crop Ins. Service Co., Inc. v. Bredeson, 437 N.W.2d 698 (Minn. App. 1989).  The inference is rebuttable, however, if the former employee can show he/she did not come into contact with any of the former employer’s customers in a way that allowed him/her to obtain a personal hold on the goodwill of the business. Webb Publishing Co., 426 N.W.2d 445; see also Midwest Systems, Inc. v. Faulkner, No. C9-97-2029, 1998 WL 252366, at *3-4 (Minn. App. May 19, 1998) (holding the inference of irreparable harm was rebutted where employee was employed by employer for only five months and was not very successful).

2.                  Monetary Damages. OLDCO might choose to sue for damages rather than injunctive relief. OLDCO may also seek both.  Monetary damages can be recovered in an action seeking injunctive relief as a remedy ancillary to equitable relief granted.  See, e.g., B & Y  Metal Painting, Inc. v. Ball, 279 N.W.2d 813, 817 (Minn. 1979).  The damages caused by a former employee’s breach of a non-compete agreement are measured by the business loss actually suffered as a consequence of the breach.  See Lemon, 2001 WL 290512 at *3 (citing Faust v. Parrott, 270 N.W.2d 117, 120 (Minn. 1978)).

a.                   Lost Business.  To establish damages, OLDCO must show by a preponderance of evidence that (a) profits were lost, (b) the loss was directly caused by the breach of the covenant not to compete, and (c) the amount of such causally related loss is capable of calculation with reasonable certainty rather than benevolent speculation.  Although the law does not require mathematical certainty in the proof and calculation of lost profits, it requires evidence of definite profits grounded on a reasonable factual basis.  See Cardinal Consulting Co. v. Circo Resorts, Inc., 297 N.W.2d 260, 267 (Minn. 1980).  Damages that are remote, speculative, or conjectural are not recoverable as a matter of law.  Busch v. Busch Constr. Co., 262 N.W.2d 377, 379 (Minn. 1977).

b.                  Lost Prospective Business.  The method of proving lost prospective profits depends on the circumstances of a particular case.  Cardinal Consulting, 297 N.W.2d at 267.  The court may consider the departed employee’s wrongfully-gained profits at his new job as a way to measure damages.  See, e.g., Cherne Indus, Inc. v. Grounds & Assoc., Inc., 278 N.W.2d 81 (Minn. 1979).  In such a circumstance, the employer must show that the departed employee’s gross income, or some of it, was specifically derived from former or prospective clients or customers who had a relationship with the employer protected by the covenant not to compete.  Id.

3.                  Contractual Remedies.  Employers can, and often do, contractually enhance their potential remedies.  This might include, for example, requiring full accountings, liquidated damages, recovery of attorneys’ fees and costs, setting damages based on a pre-determined formula, extending prohibited periods to match periods of breaches and/or providing that injunction bonds will be waived.

III. POTENTIAL DEFENSES TO OLDCO’S CLAIMS.

Non-compete agreements in the employment context are generally disfavored.[6] Freeman v. Duluth Clinic, Inc., 334 N.W.2d 626 (Minn. 1983).  They are partial restraints of trade and, therefore, are disfavored by courts and will be narrowly construed.  Bennett, 134 N.W.2d 892; Lemon, 2001 WL 290512 at *1.

A. The Agreement is not necessary or Reasonable.[7]

1.                  Not Necessary. In Minnesota an enforceable non-compete agreement must be both necessary to safeguard the employer’s protectable interests and reasonable as between the parties.  See Bennett, 134 N.W.2d at 898; Medtronic, Inc. v. Sun, 1997 WL 729168, at *3 (Minn. App. Nov. 25, 1997).  The agreement must not impose any greater restriction on the employee than is necessary to protect the employer’s business.  Bennett, 134 N.W.2d at 899.

a.                   Courts consider a variety of factors in determining whether a restrictive covenant is reasonable from a temporal standpoint, including the following: (1) nature of the work; (2) time necessary to train new employees to replace exiting employees; (3) time necessary to allow customers to become familiar with new employees; and (4) time necessary to obliterate the identification between the employer and the employee in the minds of the employer’s customers. Dean Van Horn Consulting Associates v. Wold, 395 N.W.2d 405 (Minn. App. 1986); Klick v. Crosstown State Bank of Ham Lake, Inc., 372 N.W.2d 85 (Minn. App. 1985).

b.                  Generally, agreements longer than a year are suspect. See West Publishing Corporation v. Stanley, 2004 WL 73590 (D. Minn. Jan. 7, 2004) (granting a preliminary injunction where non-compete agreement was limited to one year, employee had intimate knowledge of employer’s systems and products, did not significantly limit employee’s ability to earn a living, and was reasonable); Head, DVM v. Morris Vet. Center, Inc., 2005 WL 1620328 (Minn. App. July 12, 2005) (validating district court’s temporal modification of a non-compete clause from three years to one year where a few of vet’s clients followed her to her new clinic, but many stayed with clinic).  Even one-year restrictions may be suspect in some circumstances. See Earthweb v. Schlack, 71 F.Supp.2d 299 (S.D.N.Y. 1999) (invalidating one-year non-compete because “[w]hen measured against the information technology industry in the Internet environment, a one-year hiatus from the work force is several generations, if not an eternity.”).

2.                  Time Too Long. Employment-related non-compete agreements must be reasonable in their temporal scope, or they will not be enforced.  See, e.g., Webb Publishing Co. v. Fosshage, 426 N.W.2d 445, 448 (Minn. App. 1988) (citing Dahlberg Brothers, Inc. v. Ford Motor Co., N.W.2d 314, 321?22 (Minn. 1965)).  Courts consider a variety of factors in determining whether a restrictive covenant is reasonable from a temporal standpoint, including the following: (1) nature of the work; (2) time necessary to train new employees to replace exiting employees; (3) time necessary to allow customers to become familiar with new employees; and (4) time necessary to obliterate the identification between the employer and the employee in the minds of the employer’s customers. Dean Van Horn Consulting Associates v. Wold, 395 N.W.2d 405 (Minn. App. 1986); Klick v. Crosstown State Bank of Ham Lake, Inc., 372 N.W.2d 85 (Minn. App. 1985).

3.                  Territory Too Large. Employment-related covenants restricting competition must be reasonable from a geographic standpoint as well, or they will not be enforced.  See, e.g., Ring Computer Sys. v. Paradata Computer Networks, 1990 WL 132615 (Minn. App. 1990).  Courts consider a variety of factors in determining whether a restrictive covenant is reasonable from a geographic standpoint, including the following: (1) a “reasonable” trade area; (2) area where employee actually performed duties; (3) employer’s actual business area; and (4) location of employer’s customers.  Overholt Crop Ins. Service Co., Inc. v. Bredeson, 437 N.W.2d 698 (Minn. App. 1989).

a.                   Factors.  Courts have historically considered a variety of factors in determining whether a restrictive covenant is reasonable from a geographic standpoint, including the following: (1) a “reasonable” trade area; (2) area where employee actually performed duties; (3) employer’s actual business area; and (4) location of employer’s customers.  Overholt, 437 N.W.2d 698; Satellite Indus. Inc. v. Keeling, 396 N.W.2d 635 (Minn. App. 1986); Metro Networks Comm. v. Zavodnick, 2004 WL 73591 (D. Minn. Jan. 15, 2004) (denying defendant’s motion to stay injunction where noncompete agreement restricting defendant from doing several “restricted activities” in the Minneapolis/St. Paul metropolitan area for one year was reasonable in terms of time, geography, and scope); Universal Hosp. Serv., Inc. v. Hennessy, 2002 WL 192564, (D. Minn. Jan. 23, 2002) (granting TRO because non-compete was supported by consideration and reasonable: period of 12 months, radius of 100 miles).

b.                  Customer Restrictions.  Customer restrictions may substitute for, or complement, a geographic restriction.  See IDS Life Ins. Co. v. SunAmerica, Inc., 958 F. Supp. 1258, 1273 (N.D. Ill. 1997) rev’d on other grounds, 136 F.3d 537 (7th Cir. 1998) (applying Minnesota law); see also Madsen v. Spectro Alloys Corp., 1998 WL 373067, at *3 (Minn. App. Jul. 7, 1998) (prohibition against competing “in any market” in which employer does business was not ambiguous and not limited to employer’s territory when employee signed agreement); Farm Credit Services v. Wysocki, 627 N.W.2d 444 (Wis. 2001) (restricting employee from list of customers the employee consulted or served in the year prior to separation is not per se invalid); Commodities Specialists, Co. v. Brummet, 2002 WL 31898166 (D. Minn. Dec. 27, 2002) (granting preliminary injunction where defendant was primary contact with customers, non-compete provisions were supported by adequate consideration, one year was a reasonable temporal restriction, no geographical restriction was necessary in light of plaintiff’s international business, and plaintiff had a legitimate business interest in preventing loss of customers).

B. Lack of Consideration. Signing a non-compete agreement at the inception of the employment relationship provides sufficient consideration to support the covenant.  See, e.g., Overholt, 437 N.W.2d at 702.  However, ongoing employment is not valid consideration.

1.                  “Midstream Agreements” Must Be Supported By Separate, Independent Consideration. Where a non-compete agreement is executed after an employee has commenced employment, the agreement must be supported by “independent consideration” to be enforceable.  National Recruiters, 323 N.W.2d 736.  Even if an employee has not physically begun to work, but has already accepted an offer of employment, a non-compete agreement following the original offer of employment cannot be enforced absent independent consideration.  Sanborn Mfg. Co. v. Currie, 500 N.W.2d 161 (Minn. App. 1993); see also TestQuest, Inc. v. La France, 2002 WL 196287 (Minn. App. 2002) (affirming injunction against former sales executive because mid-stream agreement allowing the employee to continue working and obtain additional vested stock options constituted sufficient consideration); Midwest Sports Mktg., Inc. v. Hillerich & Bradsby of Can., Ltd., 552 N.W.2d 254, 265 (Minn. App. 1996); review denied (Sep. 20, 1998) (holding non-competition covenant invalid where employee knew before he began working that he would have to sign the covenant, but did not know its terms and conditions until two weeks after his employment began); See also Tonna Heating Cooling, Inc., v. Waraxa, 2002 WL 31687601 (Minn. App. Dec. 3, 2002) (holding non-compete agreement signed after employment commences is presumed unenforceable unless clearly ancillary to the employment agreement or supported by adequate consideration);  FSI Int’l, Inc. v. Shumway, 2002 WL 334409, (D. Minn. Feb. 26, 2002) (denying motion for preliminary injunction or TRO on the basis that the mid-stream non-compete agreement was not supported by sufficient independent consideration and there was no evidence of a competing product);  J. K. Harris & Co., LLC v. Dye and ABC Co., 2001 WL 1464728, (D. Minn. Nov. 16, 2001) (denying TRO because Court found that covenant not to compete was entered into after employment began and was not supported by adequate consideration).  However, where the employee signed a non-compete after starting working, but knew of the implementation of the non-compete agreement, continued working, and continued to receive monthly “draws” (or advance payments on unearned commissions), the Court held that this constituted sufficient consideration.  See Progressive Tech. Inc., v. Shupe, 2005 WL 832059 (Minn. App. April 12, 2005) (upholding non-compete agreement signed contingent with ‘draw’ agreement after employee had already begun working).

2.                  The Consideration Must Be Real. Independent consideration consists of real benefits, which are bargained for between the employee and the employer. “Real benefits” include benefits beyond those to which the employee is already entitled to by virtue of employee status or a separate contract. Sanborn, 500 N.W.2d at 161.  To satisfy the independent consideration requirement, there must be a distinction between employees who sign non-compete agreements and those who do not sign such agreements. Otherwise, the alleged “independent consideration” is illusory and insufficient to allow enforcement of a restrictive covenant.  Freeman, 334 N.W.2d at 626; BFI-Portable Services. Inc. v. Kemple, 1989 WL 138978 (Minn. App. Nov. 21, 1989).

C. The Agreement is no Longer Binding. Non-compete obligations should expressly survive termination of employee’s employment or expiration of the employment agreement.  If the non-compete clause is part of a larger agreement – for example, an employment agreement – which contemplates and allows for termination “of the agreement,” it may not be clear that the non-compete obligations survive termination of the underlying agreement.  See Burke v. Fine, 608 N.W.2d 909, (Minn. App. 2000) review denied (June 13, 2000).  Also, the language in particular contracts may require the employee’s consent to an assignment, in order for the restrictive covenant to be enforceable by an assignee of the former employer.  See, e.g., Inter-Tel, Inc. v. CA Communications, Inc., 2003 WL 23119384 (D. Minn. Dec. 29, 2003).  In addition, employers often draft merger clauses in subsequent agreements – for example, a separation agreement or release of claims – that by their terms supersede and, thus, render unenforceable, an employee’s continuing non-competition obligations.

D. OLDCO Breached. If OLDCO materially breached an employment contract with the employee, the non-compete agreement may be defeated. See, e.g., Marso v. Makato Clinic, Ltd., 153 N.W.2d 281, 290 (Minn. 1967); Prow v. Medtronic, Inc., 770 F.2d 117, 121 (8th Cir. 1985).

E. OLDCO Waived. If OLDCO failed to enforce non-compete agreements against other similarly positioned employees, OLDCO may have waived its right to future enforcement of the agreement. See Minn. Mining and Mfg. Comp. v. Kirkevold¸ 87 F.R.D. 324, 336 (D. Minn. 1980).

F. Other Contract Defenses. Legal contract defenses, such as fraudulent inducement and misrepresentation, can be asserted as defenses to non-compete agreements.  See Empiregas, Inc. of Ardmore v. Vernon Hardy, 487 So.2d 244, 249 (Ala. 1985), cert denied, 476 U.S, 1116 (1986); Richardson v. Permacel Tape Corp., 244 F.2d 80, 83-4 (5th Cir. 1957).

G. Equitable Defenses. Since employers are usually seeking an equitable remedy from the courts (injunction, etc), equitable defenses may apply, such as the equitable defense of “unclean hands.” See H & R Block v. Majkowski, 410 F. Supp. 2d 1, 3 (D.D.C. 2006); Medtronic, Inc. v. Advanced Bionics Corporation, 630 N.W.2d 438 (Minn. App. 2001); Edin v. Jostens, Inc., 343 N.W.2d 691 (Minn. App. 1984).

H. OLDCO did not Keep its Secrets Secret. The entity seeking protection of the trade secret must make a “reasonable effort under the circumstances” to maintain secrecy.  See Electro-Craft, 332 N.W.2d at 901 (quoting Minn. Stat. § 325C.01, subd. 5(ii)).   One example of measures that signal that an employer intends to keep information confidential is to require every employee to sign non-disclosure agreements.  Surgidev Corp. v. Eye Tech., Inc., 648 F. Supp. 661, 693-94 (D. Minn. 1986). If OLDCO failed to make efforts to keep its alleged secrets private, they likely will not be protected.

IV. OLDCO’S GOALS IN DRAFTING AND USING AGREEMENTS.

A. Deterrence. OLDCO’s goal is not to litigate these problems; but rather to avoid them. OLDCO wants to deter violations in the first place, if possible; and learn about its risks before – not after – they occur.

B. Damage Control. If OLDCO learns of potential violations, it wants to enhance its negotiation positions – again in hopes that it can resolve the problems short of litigation. If litigation is needed, OLDCO wants to enhance its odds of getting a temporary restraining order and/or an injunction, in hopes that it can quickly put a stop to ongoing violations.

C. Damage Recovery. If extensive litigation is needed, OLDCO wants to enhance its potential damage recovery from the former employee and from NEWCO.

V. OLDCO’S AGREEMENT STRATEGIES.

A. Anticipate Enhanced Leverage (Potential Harm). Given the nature of their responsibilities, access to information and access to and influence over other people (employees, customers, suppliers, etc), employees have many unique legal issues, as well as business and public relations leverage. OLDCO should anticipate all of this – up front.

B. Use Protective Employment Agreements. Protective employment agreements – up front – can avoid or minimize violations, reduce antagonistic negotiations and provide OLDCO with post-termination business protections that may never again become available. For example, this is a perfect time to bargain for the following post-termination protections (which should expressly survive the termination of employment, and should apply regardless of the reason for and timing of termination):  non-competition; confidentiality; non-solicitation; inventions; patents; developments; full disclosure of future business plans upon departure; return of property upon departure; non-disparagement; cooperation with litigation; and/or buy-sell agreements for shareholders.

C. Require Reasonable and Necessary Business Protections. OLDCO should not overuse non-competes or make them unreasonably long or broad. That can weaken OLDCO’s ability to accomplish its goals. On the other hand, OLDCO does not want to make it so limited that it misses the mark in the event of a later dispute. OLDCO wants to make sure that it protects – at a minimum – its  intellectual and other property, confidential information, workforce, existing customers  (wherever they are)  and  targeted prospective customers (wherever they are).

D. Make Benefit Packages Contingent on Compliance with Business Protections. Commission, bonus or other incentive plans, benefit plans, stock grant plans, stock option plans, phantom stock plans, and any number of other benefit packages are desired by key employees.  OLDCO can make any of these conditioned upon compliance with business protections; and can even provide “forfeiture” provisions in the event of breach – all part of a “carrot and stick” approach.

E. Make any Post-Termination Compensation Packages Contingent on Compliance with Business Protections. Employees often bargain for post-termination severance or other settlement agreements. OLDCO should make any such payments contingent on complete compliance with business protection obligations (as well as a release of claims).

F. Avoid Common Drafting and Implementation Mistakes. Given the changes in the job market and increased numbers of protective business agreements, there is a heightened judicial scrutiny; and there are many traps for the unwary, which OLDCO needs to avoid.

1.                  Avoid Inadequate Consideration for Non-competes.

a.                   New Employees.  New employees, including executives, should be given a conditional offer of employments, with a copy of agreement that they are expected to sign – before they begin employment; and should be required to sign the agreement – before they are put on the payroll.

b.                  Current Employees.  If OLDCO is trying to implement a non-compete agreement for existing employees, including executives, it needs to provide separate and independent consideration, which must be real and bargained for; and it needs to assure that only those that sign the non-compete receive the stated separate and independent consideration.  There are many opportunities to do this, such as those listed in V.D. above

2.                  Avoid Nullifying the Non-compete Agreement.

a.                   Post-Employment Obligations.  Post-termination obligations must expressly survive termination of employment.  Do not allow the parties to “terminate the Agreement” unless that is what you intend to provide.

b.                  Assignments.  The agreement must preserve OLDCO’s right to assign, in the event of later changes in business circumstances (mergers, acquisitions, etc.)

c.                   Merger.  Merger clauses in subsequent agreements, such as separation agreements, must not supersede the non-compete agreement.

3.                  Strengthen potential remedies. Include remedies with “teeth”, such as requiring full accountings, recovery of attorneys’ fees and costs, setting damages based on a pre-determined formula, extending prohibited periods to match periods of breaches and/or providing that injunction bonds will be waived.

4.                  Require/authorize disclosures. OLDCO should require the employee to disclose full and material information to it about potential violations; and should also require the employee to provide the agreement to NEWCO. Best case: OLDCO learns of potential problems and can deal with them.  Worst case:  the employee and/or NEWCO are on notice of the obligation and breached it.  Either way, it helps OLDCO accomplish its goals.

5.                  Anticipate multi-state issues. There are many conflicts among state laws pertaining to non-compete agreements.  OLDCO needs to anticipate these issues, and vary its agreements as needed.  Further, it is critical to include a choice of law provision and a forum selection clause, to best protect OLDCO in the event of multi-state issues.

VI. OLDCO’S POST-TERMINATION STRATEGIES.

A. Follow Up with Departing Employee and NEWCO.

1.                  As part of the exit process, OLDCO should remind (orally and in writing) the departing employee of the obligations under the agreement, provide a copy of the agreement (and document that it did so), and ask specific questions and for specific assurances as allowed under the agreement.

2.                  If OLDCO suspects violations, immediately put the employee and NEWCO on notice of the suspected violation and send needed cease and desist letters.

3.                  Follow through and do it quickly.  Delays will likely expose OLDCO to greater damages, and will make it far more difficult to get a TRO or injunctive relief later.

B. Consider Early Good Faith Negotiations for a “Win-Win”.

1.                  Consider fast, creative, multifaceted business solutions to try to get all parties what they really need and avoid litigation risks and expenses. (OLDCO may want a freeze and a stand-still agreement while the parties are negotiating).

2.                  Consider face-to-face meetings, with all knowledgeable people and decision makers present.

3.                  Consider pre-litigation mediation or arbitration.

4.                  Document any resolutions in an enforceable way. This may include an extensive three-way agreement; perhaps even a stipulated court order.

5.                  Make sure that the employee and NEWCO are both on full, written notice of their prospective obligations.

C. Prepare for Expedited Litigation. OLDCO may need to move quickly to protect its interests.  It needs to anticipate all possibilities.  Quick complaints and TRO motions are common.  Even where TROs are not sought, expedited discovery and preliminary injunction hearings are common.  Even if OLDCO is only suing for damages, non-compete/confidentiality litigation is usually viewed and treated as “urgent.”  Even if OLDCO thinks it may settle, it needs to prepare for possible litigation.

1.                  Send a cease and desist letter, and also put the former employee and NEWCO on notice of their obligations to preserve evidence.

2.                  Gather existing documentary evidence.

3.                  Gather existing electronic evidence.

4.                  Know what key witnesses will say, and consider whether statements are needed.

5.                  Anticipate and plan to address potential defenses.

6.                  Consider your internal and external communications plans, before and during the litigation.

VII. CONCLUSION.

In conclusion, employers, as OLDCO, should carefully and systematically implement reasonable policies, practices, and agreements to protect themselves from unfair competition and solicitation of their employees, and to protect their trade secrets and other confidential information.  If they do, they will go a long way toward deterring problems, enhancing their odds of successful damage control, and, as a last resort, damage recovery.  If at all possible, the best time for OLDCO to get comprehensive business protections is at the beginning of the employment relationship (after making a contingent offer of employment, subject to the business protections).  Failing that, OLDCO has many other opportunities to obtain business protections, as a condition to giving generous enhanced benefits to existing employees.  Finally, if OLDCO still does not have them in place as of the end of the employment relationship, business protections (as well as a release of claims) can be a condition of any post-termination packages.


[1]Non-compete laws are different in virtually every state, and individual agreements may or may not have choice of law and forum selection clause provisions.  It is critical to know what law applies and which Court will apply it.

[2] An entity seeking protection of a trade secret must specifically define the trade secrets that it wants protected.  Eaton; see also I.B.M. Corp. v. Seagate Tech., Inc., 941 F. Supp. 98, 100 (D.Minn.1992) (finding general knowledge within an industry does not constitute trade secrets and that employer must identify specific trade secrets which are subject to protection);  NewLeaf Designs, LLC v. BestBins Corp., 168 F. Supp.2d 1039, 1044-45 (D. Minn. 2001) (finding moving party proffered only general information containing too little detail to show why its “customer lists, market intelligence, business plans, supplier information and operating information” should constitute trade secrets).  The test used to determine whether information constitutes a trade secret is embodied in Minn. Stat. § 325C.01, subd. 5 (1982): “Trade secret” means information, including a formula, pattern, compilation, program, device, method, technique, or process, that: (i) derives independent economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and (ii) is the subject of efforts that are reasonable under the circumstances to maintain its secrecy.”  Electro-Craft, 332 N.W.2d at 899 (emphasis in the original);  Widmark v. Northrup King Co., 530 N.W.2d 588 (Minn. Ct. App. 1995).

[3] Misappropriation involves the acquisition, disclosure, or use of a trade secret through improper means.  Electro-Craft, 332 N.W.2d at 903; Minn. Stat. § 325C.01, subd. 3.  The UTSA defines “improper means” as: “theft, bribery, misrepresentation, breach or inducement of breach of a duty to maintain secrecy, or espionage through electronic or other means.”  Minn. Stat. § 325C.01, subd. 2.  To prove misappropriation, the plaintiff “must establish that defendants acquired the trade secret as a result of a confidential relationship, and that defendants have used or disclosed the trade secrets.”  Surgidev, 648 F. Supp. at 694 n.16 (citing Jostens v. National Computer Sys, Inc., 318 N.W.2d 691, 701 (Minn.1982)).  See Fox Sports Net North, L.L.C., v. Minnesota Twins Partnership, 319 F.3d 329 (8th Cir. Ct. App. (2003) (sports television network could not show that either major league baseball team or its chief operating officer (COO) were privy to any of networks confidential information, as required to prove misappropriation of trade secrets claim under MUTSA, because he did not have access to any information related to the network, and prior telecast agreements were not protected as trade secrets, as predecessor did not mark them as confidential); Luigino’s Inc., v. Peterson, 317 F.3d 909 (8th Cir. Ct. App. 2002) (corporation’s research and development information, financial information, income statements and volume and sales margins were merely general categories of information, insufficiently specific to qualify as trade secrets, for purposes of misappropriation of trade secrets claim, under Minnesota law).

[4] Generally, “[i]n the absence of a covenant not to compete or a finding of actual or an intent to disclose trade secrets, employees ‘may pursue their chosen field of endeavor in direct competition’ with their employer.”  Seagate, 941 F. Supp. at 101 (citing Surgidev, 648 F. Supp. at 695).  The fact that an employee has knowledge of his or her former employer’s trade secrets and currently holds a comparable position with a competitor is insufficient to justify injunction; “a claim of trade secret misappropriation should not act as an ex post facto covenant not to compete.”  Id. (citing E.W. Bliss Co. v. Struthers-Dunn, Inc., 408 F.2d 1108, 1112-13 (8th Cir.1969);  see also Lexis-Nexis 41 F. Supp. at 959 (following Seagate and refusing to grant injunction allowing employer to “obtain, through the back door of trade secret law, the kind of unreasonable restriction it could not obtain via its original non-compete agreement”).

[5] At the time such an agreement is made, the employer must provide the employee with written notice that the agreement “does not apply to an invention for which no equipment, supplies, facility or trade secret information of the employer was used and which was developed entirely on the employee’s own time, and (1) which does not relate (a) directly to the business of the employer or (b) to the employer’s actual or demonstrably anticipated research or development, or (2) which does not result from any work performed by the employee for the employer.”  Minn. Stat. § 181.76.  Existing employees should be provided independent consideration to support such agreements.  See Eaton Corp. v. Giere, 971 F.2d 136, 139-40 (8th Cir. 1992).

[6] Minnesota law recognizes a distinction between non-compete agreements associated with employment contracts and those arising as part of the sale of a business.  Kunin v. Kunin, 1999 WL 486814, at *3 (Minn. App. July 13, 1999), citing Bennet, 134 N.W.2d at 899.  The reasonableness of a non-compete agreement in the sale of a business context is determined by a three-step test:  “(1) whether the restriction exceeds the protection necessary to secure the goodwill purchased; (2) whether the restriction places an undue hardship on the covenantor; and (3) whether the restriction has a deleterious effect on the interests of the general public.”  Id., citing Bess v. Botham, 257 N.W.2d 791, 795 (Minn. 1977) (prohibition preventing former salon owner from having “any interest in any hair salon anywhere in the United States for 11 years” was upheld as reasonable).

[7] The reasonableness inquiry is on a case-by-case, fact-specific basis. Davies & Davies Agency, Inc. v. Davies, 298 N.W.2d 127 (Minn. 1980).  Different jurisdictions use various methods of addressing overly-broad and unreasonable covenants.  Some courts hold restrictive covenants totally unenforceable if they are unreasonable in scope or duration.  See, e.g., Fields Found Ltd. v. Christiansen, 309 N.W.2d 125 (Wis. App. 1981).  Such courts may take this approach in order to encourage employers to write more narrowly-tailored covenants.  See Telxon Corp. v. Hoffman, 720 F. Supp. 657 (N.D. Ill. 1989).  In other jurisdictions, the courts will “blue pencil” invalid portions of the agreement, and enforce the rest as written.  See BDO Seidman v. Hirshberg, 93 NY.2d 382, 394 (N.Y. 1999).  Minnesota courts utilize a modified “blue pencil” doctrine and will rewrite portions to make them reasonable.  Dean Van Horn Consulting Assoc. v. Wold,, 395 N.W.2d 405 (Minn. App. 1986); Ikon Office Solutions, Inc. v. Dale, 2001 WL 1269994 (8th Cir. Oct. 24, 2001).

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